On December 8, 2014, the Financial Conduct Authority (FCA) announced a major internal restructure and strategic shift in the way that it will supervise authorised firms. The changes will commence from January 5, 2015 and will be fully in place by April 20151. Firms that might have benefited from a "light-touch" supervisory approach in the past, should expect more activity-based and thematic scrutiny from the FCA in the future.
In 2012, the FCA committed to a three-pillar model of supervision2 and, shortly before its inception, every firm or group the FCA was going to regulate was assigned to one of four categories of conduct supervision (C1, C2, C3 and C4)3. The vast majority of regulated firms – including most hedge and private equity fund managers, as well as commodities firms – fall into the C3/C4 categories.4
The three-pillar model is based on proactive firm supervision (Pillar 1), event-driven, reactive supervision (Pillar 2), and issues and products supervision (Pillar 3).5 The conduct categories are broadly based on commercial size, retail customer numbers and wholesale presence with C1/C2 firms judged as having a more significant market presence than C3/C4 firms.6 Typical examples of C1/C2 firms include banks, insurance companies and larger investment firms.
One of the consequences of these categories is that, whereas C1/C2 firms are supervised more intensively across all three pillars (e.g. most have a relationship manager and receive regular onsite visits covering a range of issues), C3/C4 firms receive significantly less scrutiny.
For example, a number of C3 firms lost a dedicated contact at the regulator with the transition from the former Financial Services Authority to the FCA, with the FCA’s Pillar 1 supervision based almost solely on annual returns and outliers identified in periodic peer group assessments. Likewise, C4 firms receive even less scrutiny with a “touch point” (e.g. a telephone call or online assessment) occurring only every four years. On the whole, this lighter touch approach to supervision of smaller firms has been reactive and/or based on certain thematic trends (i.e. under Pillar 2 & 3).
The FCA’s sharpened focus
The FCA has now suggested its lighter touch approach to supervising C3/C4 firms has come under strain and that it intends to sharpen its focus on supervision of smaller firms, in particular, by removing the distinction between C3 and C4 firms and ceasing most Pillar 1 activity with C3/C4 firms.
This change in focus also will be accompanied by structural reforms at the FCA, including the integration of the FCA’s risk and supervisory oversight functions into a dedicated Risk Division and the FCA’s supervision and authorisation functions into a new Supervision Division. From April 1, 2015, the supervisory function is expected to be separated further into two new divisions, based on “a clearer distinction” between the FCA’s approach to regulating large and smaller firms.
This shift by the FCA is likely to mean that many firms that might have benefited from a "lighter touch" strategy in the past should expect greater supervisory scrutiny in the future, depending on the activities they carry out and the key risks of the day. While not a brand new philosophy for the FCA7, this change in focus should see a shift away from supervisory interaction (and perhaps enforcement interest), often led by quantitative factors such as financial size and number of customers, to an emphasis on qualitative factors such as the activities carried on, the markets participated in and the types of customers and counterparties impacted.
For many firms, this will mean that their supervisory interactions with the FCA will become more event-driven and based on thematic work. To avoid being caught out and be able to judge where interactions with the FCA are likely to arise, it is more important than ever that firms stay on top of the messaging coming out of the FCA. This includes reviewing FCA press releases and the FCA’s annual risk outlook and business plan8.